Monday, March 09, 2009

Are CRA, Clinton and Carter Really to Blame?

by Harold Black

I am fed up with the conservative talk show hosts putting the blame of the current economic crisis on the Community Reinvestment Act. I’ve heard them say that the CRA was signed into law by Jimmy Carter and aggressively expanded under Bill Clinton forcing banks to make loans to people who could not afford them. Fannie Mae and Freddie Mac were also forced to buy these loans. Since people could not afford them, they defaulted causing the failure of Fannnie and Freddie and precipitating the crisis.

As my father used to tell me, “Harold, that sounds good if you are interested in sounds”. But what is the truth? The truth is that republican presidents rather than democrats were ultimately responsible. When I was Deputy Director of Economic Research at the Comptroller of the Currency, the Congress passed the Equal Credit Opportunity Act in 1974 and the Home Mortgage Disclosure Act in 1975. I was charged with determining if national banks (those who received their charter from the federal government) were guilty of discrimination and of redlining. Discrimination is the act of denying a person a loan based on a prohibited basis such as race. Redlining is the denying a loan to anyone regardless of race who is applying for a loan in a specific geographical area.

My study (published in the American Economic Review, "Discrimination in Mortgage Lending," (with R. L. Schweitzer and L. Mandell), May 1978, v. 68, n. 2, pp. 186-192) showed weak statistical evidence of racial discrimination in the accept/reject decision but no evidence of redlining. These acts and our research at the OCC laid the foundation for other research on discrimination and to the passage of the CRA in 1977.

Although the CRA was signed into law by Jimmy Carter, two other important acts the Equal Credit Opportunity Act (ECOA) and the Home Mortgage Disclosure Act (HMDA) were signed by a republican, Gerald Ford. The talk show hosts also state that Bill Clinton was responsive for the expansion of CRA and forcing the banks to make bad loans. However, the two major changes in the CRA occurred in 1989 with the passage of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) and the Federal Housing Enterprises Financial Safety and Soundness Act of 1992. Both were signed into law by George H. W. Bush. Under FIRREA, the reporting requirements of CRA compliance were expanded. The latter act required Fannie Mae and Freddie Mac to support affordable housing by purchasing CRA-qualifying loans. Even though the talk show hosts have said that up to one half of Fannie and Freddie loans were CRA loans, the act suggests that by the year 2010, that one-third of their purchases be affordable housing loans.

If there were pressures to expand CRA lending, it came in part from the banks themselves. As a result of the Riegel-Neal Interstate Banking and Branching Act of 1994, signed into law by George W. Bush, CRA ratings became an important factor in determining if banks could merge or acquire across state lines. Because advocacy groups would use CRA ratings as a protest against the banks in order to get additional CRA lending, the banks greatly expanded these types of loans. I recall going to a Fed Atlanta conference on CRA lending, compliance and enforcement. A banker told me that the Feds never pressured him into making a bad loan. However, because they wanted to expand into other states, they had instituted a more liberal CRA lending policy. So the truth is that if there is blame to be handed out for a misguided CRA policy, it has to be laid at the feet of the republicans and the banks. Jimmy Carter and Bill Clinton are convenient whipping boys and are well deserving of other blame but CRA lending is not one of them.

As to the banks making loans to people who could not pay them back? We in Finance have a technical term for such lenders – it is a fool. This makes no sense at all. Some people will say that the bankers could make bad loans because they would be sold to Fannie Mae and Freddie Mac. Well most CRA mortgages and subprime mortgages were sold to private investors. If these loans defaulted within 90 days, then the purchasers would put them back to the originator, If they defaulted later and more bad loans were made by the originator, then the investors would either not buy them or would offer low prices on mortgage pools of the originator. Either way, the originator would lose and would quit making bad loans.

Lastly, there are too few subprime mortgage to have caused the financial crisis. At year end 2008, there were $1.3 trillion in subprime mortgages. The default rate on subprimes had increased from 8 percent to around 20 percent. If you assume 100 percent loss on the defaulted mortgages, then this totals $260 billion. Well in 2008 the total loss in mortgage backed securities was $435 billion. If subprime defaults were at fault, then there would have been no need for the $800 TARP package. So like Carter and Clinton, subprime is just a convenient whipping boy. As my readers know, I am a laissez-faire free market conservative. But that does not blind me to the truth.

Harold A. Black is the James F. Smith, Jr. Professor of Finance, University of Tennessee, Knoxville. He has served on the faculties of American University, Howard University, the University of North Carolina - Chapel Hill and the University of Florida. His government service includes the Office of the Comptroller of the Currency and as a Board Member of the National Credit Union Administration. Dr. Black blogs at Caveat Emptor where he originally published this article. It is reprinted on this blog with his permission.

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  1. Great point about the number of sub-prime mortgages and how they could not have caused the crisis alone. Rarely is that point made loud enough.

  2. There's certainly a lot of blame to go around regarding this financial/housing crisis. I am tired of seeing Republicans blaming Democrats and Democrats blaming Republicans solely for this mess. They both share blame and the blame doesn't end there. They should just shut the hell up and work together and try to fix this mess. Or am I expecting too much out of either one of them?

  3. In Harold's words, the data in his study showed "weak statistical evidence of racial discrimination in the accept/reject decision but no evidence of redlining."

    If this is true, then why would this have led to "other research on discrimination and to the passage of the CRA in 1977."


  4. Click here for the other side of the story.

    There, you will learn -- among other things:

    1) That multiple academic studies have thoroughly debunked the whole red-lining nonsense.

    2) That Clinton and a whole host of other Democrats -- in pursuit of housing policies which went well BEYOND the CRA -- WERE primarily responsible for the present housing mess.

    3) Even CRA apologists -- like Elizabeth Duke -- freely admit that subprime loans are absolutely, positively the epicenter of the current housing mess. Any assertion to the contrary has NO CREDIBILITY what-so-ever.

    Unlike the host of this blog, I am not now and never have been a Republican. But, I have no doubt that any given Dim administration is far, far, FAR worse than the worst ever Republican administration. And, the current administration is the worst EVER -- by FAR!

    P.S.) If you want anybody to believe any of your assertions, I suggest you substantiate them.

  5. Your assertion about too few subprime mortgages is correct, but I lose you when you divert blame away from the instigators of the subprimes as being the cause of this catastrophe.

    In 1998 the Clinton administration sued a company called Accubank, forcing it in the settlement to write $2.1 billion worth of subprimes. In 1999 Clinton repeated this trick, this time forcing Columbia Mortgage to write $6 billion of loans that it would never otherwise have made. You can see Andrew Cuomo, Clinton's secretary of HUD, proudly proclaiming these victories on YouTube.

    The banks got the idea. If you don't write bad loans, the government will sue you and you'll end up making them anyway. If you do write bad loans, the government will guarantee them. Basically the Clinton administration had opened the gate and chased the banks out of the reality corral using a whip.

    I think it is somewhat bizarre to fail to hold Clinton responsible for the fact that the banks followed his irresistable incentives with gusto. The guy who blows up the dam is resoponsible for the damage. We don't blame the water, which does thousands of times more damage downstream, for the disaster.